Memorandum by the New Policy Institute
The New Policy Institute is an independent think
tank, founded in 1996. Its mission is to further the cause of
social justice in a market economy. The New Policy Institute has
been working on water policy since 1997 and has produced two publications
on the subject: Fair and SustainablePaying for Water (1997)
and Water Charging and Social Chargingwhy politicians must
act (2000). On a closely related subject, it also published Council
Taxthe case for reform (1999).
This submission focuses on the implications
of the Bill with regard to water charging for domestic customers.
This is an area of water industry policy in which customers' interests,
social policy and environmental sustainability are intertwined.
We welcome Part II of the new Bill and in particular:
The proposals for the Consumer Council
for Water (Clause 23). The Council is likely to put pressure on
Ofwat to treat the needs of customers (including vulnerable customers)
as a high priority.
The Director General's new objective
to protect the interests of consumers (Clause 27). We particularly
welcome the specific obligation to take into account the interests
of people on low income.
The Director General's obligation
to take into account Statutory Guidance on Social and Environmental
matters (Clause 28). Although Ofwat already has specific duties
associated with environment and social policy, this clause will
enable the government to ensure that regulatory activities are
compatible with environmental and social policy.
However, it is important to note that people
on low income make up a substantial minority of the population.
On the government's own definition, the latest official figures
show that nearly one in four people in the UK live in poverty,
while many more people live on incomes only a little above this
threshold. Against this background, only a fundamental reform
of water charging can protect the interests of the substantial
minority on low income. In our judgement, the proposed extension
of the regulator's remit to include social, customer-care and
environmental responsibilities can be the catalyst for this fundamental
This submission has three parts to it:
A discussion of some of the key issues
to do with domestic water charging.
Proposals for alternative charging
A discussion of the relationship
between charging and competition.
In addition, an attachment, based on edited
extracts of an earlier New Policy Institute paper considers in
more detail the feature of a charging system that can satisfy
both social, economic and environmental concerns.
How water is paid for
There are currently two ways of paying for domestic
Around 20 per cent of households
pay a variable or measured charge, based on level of water use,
as measured by a meter.
Around 80 per cent of households
pay a charge that is independent of usage. In England and Wales,
this is based on the rateable value (RV) of their homes.
Almost all homes built since 1990 have meters
fitted, while other households may opt (or if they use water for
non-domestic purposes, may be required) to have a meter fitted.
Bills usually consist of a standing charge and a volumetric element
that rises in line with increasing water use.
In England and Wales, almost all unmeasured
charges are based on the rateable value (RV) of homes, which were
last assessed in 1973 (as with measured charges, bills usually
consist of a fixed standing charge, plus the element of the charge
which is varied according to the RV). In 1998 the government decided
to continue with this approach to unmeasured charges, even though
it acknowledged that a large number of homes would remain on unmeasured
charges for the foreseeable future, while over time, RVs will
become more arbitrary and unfair as they become ever more out
Charging according to "ability to pay".
It is important that social considerations affect
the terms on which customers are supplied water, because water
and sewerage are "essential services", just like education
At the moment the government's "social
policy" for water currently encompasses three policies. In
our view only the third offers an adequate approach to protecting
the interests of low income customers.
The right of universal access to
waterit is now illegal for companies to cut off or limit
water supplies. We believe, however, that this right needs to
be accompanied by charging structures which make water services
affordable, otherwise many customers will not pay their bills,
leaving companies to shoulder the costs.
"Safety Net" charging policies
which protect the most vulnerable. The government has introduced
regulations which protect very vulnerable metered customers who
use large amounts of water. But the groups receiving help are
small (people with certain medical conditions and large families
on income support) and currently companies are only required to
lower their charges to the average billing level. In our view
this is not an approach which can provide security to the majority
of families on low incomes or to the companies which provide them
Building the "ability to pay"
principle into the whole charging system. There is some evidence
to believe that government now accepts that, because water is
an essential service, it is legitimate to adopt a "public
sector model" of equal access to services, with payment through
charges which resemble progressive taxes. This approach, rather
than special measures for particular customer groups, can ensure
that water is affordable to the millions of customers on low incomes.
While the government is committed to maintaining this approach
in unmeasured charging, we believe that it has to consider how
to extend it to measured charging.
The Instability of the two tier system
The current two-tier system, where RV-based
unmeasured charges and measured sit side by side, has a series
Since the government came to power, it has placed
a new emphasis on the rights of customers, by allowing unmetered
customers to choose between charging systems, without interference
from water companies (the same right has not been extended to
most metered customers).
Although this appears to entrench the existing
two tier system for the foreseeable future, in fact this policy
has created a highly unstable and inequitable situation. This
is because it is currently in the interests of households in high-RV
homes, who use little water, to switch to meters. As these families
save money by shifting to meter, water companies also lose revenue.
They are obliged to recover this revenue from all their customers
(because they are not allowed to discriminate between measured
and unmeasured customers) so unmeasured charges rise. A vicious
circle follows: as unmeasured charges rise, so more high-RV homes
switch to meters, forcing up all unmeasured charges still further.
Meanwhile people in low-RV homes, who pay less than they would
under a measured charge, have no choice but to pay more, either
through the unmeasured bill, or by switching to a meter. This
amounts to an indirect transfer of resources from poorer customers
to richer ones, and the hidden unravelling of a century-old, socially
equitable distribution of payment.
Our recommendation is that the government introduce
reform to stem the unravelling of socially equitable distributions
of payments and develop charging structures which incorporate
social, environmental and economic principles. In brief, there
are two elements to the reform:
Replace unmeasured charges based
on RVs with ones based on Council Tax Liability.
Replace current measured tariffs
with a hybrid-system including an "ability to pay" component.
Replacement for unmeasured charges
The government turned this option down in 1998,
mainly on the grounds that reform would be administratively complicated
and that transition to the new system would create many losers
in the short term. But given that unmeasured charging is set to
remain for the foreseeable future, this is an issue which will
re-emergethere will come a point when it is simply not
tenable to use 40 or 50-year old valuations for assigning charges.
In our view, issues of administration and confidentiality can
be overcome. This would ensure that unmeasured charging remains
on a footing that is fair and perceived to be fair for the foreseeable
To implement this reform parliament would need
to amend the Local Government Act 1992, which restricts the use
of Council Tax data. It may also need to amend the Data Protection
Act, although legal advice would need to be taken on the compatibility
of individual companies' plans with the act. We recommend that
any necessary amendments are included in the eventual Bill.
Replacement for current measured tariffs
Council Tax data could also be used to introduce
a social dimension to measured bills. The most straightforward
approach would be to set standing charges according to Council
Tax liability, and then apply a volumetric charge on top of that,
with a built-in allowance of free or very cheap, water for essential
use. This reconciles the "Level of Use" and "Ability
to Pay" principles in a coherent way, providing protection
for the environment, and allowing companies to recover their marginal
costs, while also delivering socially equitable outcomes.
The details of our proposals are discussed in
the attachment, which is an edited extract from our 1997 report,
Fair and Sustainable: Paying for Water.
We are not aware of any legislative barriers
to these proposals, beyond the restrictions on the use of Council
Tax data. Once the new social and environmental objectives are
in force, Ofwat could itself initiateor be directed by
the government to initiatethe process of charging scheme
reform. We feel, however, that there may be merit in placing such
a considerable reform on a statutory footing, through the inclusion
of an additional clause in the eventual Bill.
It is our assumption that the eventual Water
Bill will include clauses providing the Regulator with a clear
legislative framework for the regulation and approval of competition
and restructuring within the water industry.
Quality issues notwithstanding, water is essentially
a standard product which is already freely available. From the
consumer perspective, therefore, competition will only really
have benefits if it results in reduced prices. If competition
results in reduced costs which can lead to reduced prices to all
consumers, then clearly this is to be welcomed. But our concern
is that much of it may take the form of reduced prices to selected
"profitable" consumers. Other things being equal, this
would then create a pressure for higher prices to "less profitable"
consumers, so that total revenues were maintained. In other words,
competitors would "cherry pick" the "overcharged"
customers to whom they can deliver price cuts, at a profit, leaving
the incumbent company to struggle with the loss-making, "under-charged"
The government is aware of these problems. In
the context of water, it is clear that it wants to introduce measures
which (1) ensure that all have access to new entrants' services;
(2) require new entrants to deliver the same "safety net"
social tariffs as existing incumbents; and (3) continue to cross-subsidise
customers in rural and urban areas by ensuring that bills do not
vary according to geographic location.
While these safeguards are welcome, we are concerned
that very little has been said about the protection of existing
differential tariffs which arise because RV-based charging already
includes an element of "ability to pay". For example,
if new entrants vigorously promote flat-rate unmeasured charges,
or cheap measured charges, customers with high RVs but low water
usage will take up these options, leaving incumbent companies
with low RV customers, who they would then need to charge higher
prices. This is, in other words, an acceleration of what is already
happening in the 'competition' between metered water and unmetered
The policies adopted to prevent cherry-picking
in other regulated sectors would not prevent this problem, because
such measures usually involve the requirement for all companies
to offer a uniform price to all, regardless of circumstances.
In water, because the dominant RV-based charging structure already
includes an element of "ability to pay" this would actually
drive cherry picking and the unravelling of socially desirable
We conclude that competition must be achieved
on the basis of cost-effectiveness rather than the adoption of
alternative tariff structures. In other words, the future regulatory
regime must be such that competing companies all have to adopt
broadly similar tariff structures. If a company can achieve lower
costs, then it could then offer lower prices to all potential
We conclude that settling the strategic shape
of future tariff structures is a prerequisite to the introduction
of widespread competition. Unless the government is prepared to
see poorer customers, who are currently without meters, hit hard
these tariffs will clearly need to include an 'ability to pay'
element. As we have argued earlier, this implies the introduction
of an ability to pay element into measured charges, probably based
on Council Tax liability.
ATTACHMENT CRITERIA FOR A WATER CHARGING
The choice of a new charging system is a commercial
decision for the water companies to make. But the unique status
of water means that the decision has considerable social and environmental
implications. The government therefore has a proper interest in
Through OFWAT, the government already takes
an interest in the overall level of charges to households. As
a steward of the environment, it has an interest in seeing that
there are incentives for the sensible use of water by both the
water industry and consumers. For reasons of social justice, it
also has an interest in the mix of charges between households.
There is no reason to suppose that the public
interest is necessarily or inevitably at odds with the water companies'
interest. Instead of proceeding on this basis, assuming the problem
to be an inherently adversarial one, the government could try
to lead the water companies towards decisions that would command
political and public support.
We propose that the government should exercise
its leadership by setting out criteria relating to the effects
of any new system of payment. the Criteria we suggest are that
a system of charging should:
Be efficient in economic terms.
Sustain the environment.
Produce socially just outcomes.
There are certainly other important attributes
that any charging system should possessfor example, to
be understandable to usersbut criteria of efficiency, sustainability
and justice are likely to be fundamental determinants of the acceptability
or not of any system.
Applying the criteria
One way of applying these criteria is to frame
a set of more specific questions to ask of any particular charging
system. In order to meet a particular criteria, a charging system
must provide a satisfactory answer to all of the questions associated
with it. For example:
|Criterion||Questions to ask to establish whether the criterion is met. Does the system:
|Economic efficiency||Allow for water to be appropriately priced at the margin?|
Provide a balance of incentives for both households and water companies to use resources efficiently?
|Sustain environment||Help protect the ecosystem, in terms of both the quantity and quality of water?|
Address the strategic water problems foreseen by the water company in its region?
Stimulate water companies to promote non-financial measures for the saving of water?
|Social justice||Protect households from pressure to economise on water where health and hygiene could suffer?|
Reflect consumers ability to pay for water to meet essential needs?
Include payment options to help with budgeting and arrangements for exemptions and rebates?
Any system put forward to solve the strategic problems should
be required to satisfy all the criteria and not just some.
Current charging systemthe two extremes
There are two extreme forms of water charging systems. One
is where the bill is independent of the volume of water used and
is wholly determined by the fixed charge. The other is where there
is no fixed charge and where the bill is proportional to the volume
of water used. Interestingly, these extremes are close to representing
the two systems actually in existence for households in England
and Wales at the moment:
Most households currently pay for water via a
fixed charge only, set according to rateable values (see ..........
line in the diagram below).
The minority of households who are now metered
pay according to the volume of water they use, plus a small fixed
charge (see - - - - - - - line in diagram below).
Clearly, it is possible to "mix and match" the
charges with a combination of fixed charge and volumetric charge.
Two possible examples are:
A tariff structure that combines a standing charge
with a volumetric charge that only starts to apply above a given
level of "basic" water usage (the - - - - - - - line
A block tariff structure, where the amount paid
still depends on the volume of water used but does not vary continuously
with it (the .......... line overleaf).
This analysis highlights the observation that any water charging
system combines a level of fixed charge with one or more volumetric
charges for differing volumes of water usage. The practical questions
in devising a particular tariff structure then concern:
The relationship between the fixed charge and
the volumetric charge(s).
Whether any of them should vary between households.
How the information necessary to set a particular
household's tariff should be obtained.
If the marginal price (which corresponds to the slope of
the line in the diagrams above) is too low, then the consumer
has little incentive to economise on usage. Conversely, if the
marginal price is too high, then the supplier has little incentive
to encourage its consumers to economise on usage. Theories of
economic efficiency suggest that, over time, the price paid by
the consumer for an extra litre of water at the margin should
equal the cost incurred by the water company in providing that
additional water (plus, perhaps, the environmental costs).
Note that economic efficiency is only concerned with the
cost at relatively high levels of usage (where the consumer is
faced with a decision whether or not to use water) and not at
lower levels of usage (where the consumer will use the water anyway).
So any charging system where payment according to the volume used
starts to apply above a certain level of consumption is in principle
capable of satisfying this efficiency criterion.
Like economic efficiency, environmental sustainability may
also depend on the marginal price, because any element of charging
for water according to volume used creates financial incentives
for households to economise. But, as there is no reason to suppose
that households will respond only to price incentives, it is important
that water companies also have the incentive to encourage such
economy by other, non-financial means. This requires that the
marginal price paid by households be no greater than the marginal
Social justice on the other hand depends much more on the
total bill (both volumetric and fixed charges). So, for example,
the fixed charge should be such that it is affordable for poor
families and the costs at low levels of usage should be such that
no household is unable to afford the water for ordinary domestic
usage that it needs for essential purposes.
Assessment of the current schemes
Applying these principles shows that none of the present
charging systems is adequate:
Flat rate charging systems, such as the present
ones based on rateable values or council tax bands, cannot satisfy
either the economic or the environmental criteria because the
marginal price of water is zero. On the other hand, the present
flat rate systems are to some extent a proxy for the ability to
pay, and may therefore meet the criterion of social justice.
The present tariff for metered customers also
seems to fail to satisfy the economic criterion, but for the different
reason that its marginal (volumetric) price is arguably too high
compared with the future long run marginal cost. As a result,
the tariff structure does not provide a proper balance of financial
incentives as it leaves water companies with little or no financial
interest in households saving water. Moreover, as the fixed charge
element is levied as a uniform fee per household, it also cannot
meet the social justice criterion, as water bills are unrelated
to customers' ability to pay.
Assessment of a hybrid scheme
Although the present metered tariff does not meet the criteria,
it is possible to see how it could be altered to ensure that it
did. For example:
First, if the volumetric charge for water were
reduced to bring it into line with a revised view of the long
run marginal cost of water, both the economic and the environmental
criteria could be met.
Second, if volumetric charging were only to begin
once a household exceeded its "basic usage" (set to
reflect essential water needs), this would contribute to the social
justice criterion being met.
Third, the fixed charge would need to be raised
to offset the fall in the water companies' income, resulting from
the two changes above. But if this higher standing charge were
allocated among households according to some proxy for the ability
to pay, for example, Council Tax banding, then the social justice
criteria could still be met.
We conclude that charging systems can be found that satisfy
the multiple criteria of economic efficiency, environmental sustainability
and social justice. But they have to be sophisticated systems.
Whilst this implies widespread metering, the accompanying tariff
must reflect social justice concerns in a way that the present
metered tariff does not.
Opposition to metering
There is continuing opposition to metering itself, usually
from bodies representing the interests of consumers, whether in
the water industry or more generally.
We acknowledgeindeed we emphasisethat there
are serious objections to an extension of metering on the present
tariff; objections economic, environmental and social. But the
fundamental fault lies with the tariff structure and the principles
on which it has been constructed by the water companies, at the
behest of the last government and OFWAT. We believe it is vital
to distinguish between metering and the tariff structure, directing
criticisms at the latter, because metering itself provides information
on usage that will help manage society's use of water in the coming
Practicalities of sophisticated charging systems
There are also a number of problems which arise from the
sophisticated tariff structure needed to meet multiple criteria.
The cost implications of gathering additional
information and administering the system;
The setting of household-specific thresholds (eg
for basic usage);
Concerns arising from the confidentiality of some
of the information required.
We recognise all of these as important issues which need
to be addressed in any fully fledged solution. However, they should
not be insuperable, given additional research, a realistic timescale
for implementation and appropriate co-operation between the water
companies and local authorities, who may have a significant role
to play in overcoming some of these obstacles.
Edited extracts from Fair and Sustainable: Paying for Water,
New Policy Institute, 1997. Back